“The rapid pace of credit growth, its relatively long duration, and tilt towards real estate has increased systemic financial risks. Strong credit growth commenced in 2003–04, was briefly interrupted in 2009, and reached 30 percent year on year on average between 2010 and 2016. Although credit growth moderated to near 20 percent in early 2017, the credit gap remains large and is estimated to exceed 10 percent of GDP. Real estate, construction and mortgages have been the fastest growing segments of lending, with growth rates exceeding 50 percent in recent years, before slowing in 2016. Lending to the construction, real estate and mortgage sector accounted for 21.5 percent of the total credit stock at end-2016.

The rapid expansion of the real estate sector, funded in part by external borrowing, has led to a build-up of macro-financial stability risks. Rapid construction risks an eventual oversupply in the real estate market, which could precipitate a disorderly adjustment (with the risks particularly pronounced in the middle-range condominium segment, which has been mostly driven by foreign investors), adversely affecting the banking sector via a spike in NPLs, potentially putting a drag on credit growth and economic activity (see Article IV 2016). The critical link between capital flows and real estate projects was illustrated in 2009, when a reversal of flows led to the collapse of major construction projects, particularly in Phnom Penh, contributing to a severe if temporary economic slowdown.

The authorities have sought to address the risks stemming from significant capital inflows and credit growth through a range of macroprudential measures:

Liquidity tools. Reserve requirements have been the main instrument used to contain excess liquidity fueled by external funding, and to moderate the pace of credit growth. In 2008, the NBC doubled the reserve requirement on foreign currency bank deposits to 16 percent amid large sustained capital inflows, although this was subsequently relaxed to 12 percent in early 2009 during the global financial crisis. As inflows resumed, the authorities raised bank reserve requirements for foreign currency deposits again by a slight 50 basis points to 12.5 percent in September 2012. To address risks associated with growing non-core funding sources, banks’ external borrowings were included in the reserve requirement base in March 2015. Reserve requirement rates are now 8 percent for local currency liabilities (unremunerated) and 12.5 percent (of which 4.5 percent is remunerated) for foreign currency liabilities (including external borrowing).

Broad-based capital tool. Regulatory increases in minimum capital requirements have aimed at further strengthening the resilience of the financial sector.

Sectoral asset-side tool. A lending cap of 15 percent was imposed on the property sector of banks’ total loan portfolios in 2008.

The authorities have also aimed to contain risks pertaining to real-financial linkages which could increase procyclicality. In addition to a lending cap on the property sector imposed in 2008, the authorities have recently tightened licensing and supervision on real estate developers, and expanded the coverage of stamp duty on real estate transactions (without differentiating by residency). A new regulation effective April 2017 caps the interest rate on all MFI loans at 18 percent, regardless of loan maturities. This reflects the authorities’ concerns about excessive debt accumulation in rural areas.

The Article IV consultations in 2015 and 2016 recommended additional measures to build resilience and help engineer a soft landing of the credit cycle. While supervisory capacity has improved since the 2010 FSAP recommendations, gaps in financial supervision and regulation have remained. A critical challenge highlighted was to close the regulatory gap stemming from the fact that MFIs are competing with banks for the same funding base and are subject to similar credit, liquidity and FX risks as banks, but subject to looser regulations. Article IV consultations recommended an expanded range of micro and macroprudential tools. These include sectoral tools such as higher risk weights, concentration limits, and LTV/DTI limits on real estate lending; and liquidity tools such as limits on LTD ratios to strengthen internal sources of funding and serve as a brake on excessive credit growth.”